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A recent Tax Court of Canada decision has concluded that various expenses incurred in response to a hostile takeover bid, including so-called hello and break fees, are fully deductible.

In this case the target corporation received an unsolicited offer for the purchase of all of its common shares. Immediately after this proposal, the target's directors engaged the services of financial advisers to determine, generally, the fairness of the offer. Further, the target sought a white knight, which it found. The original offeror's second offer (which trumped that of the white knight and triggered the break fee payable to it) was ultimately accepted as being reasonable and the original offeror acquired all the issued and outstanding shares of the target.

The target deducted fees paid to the financial advisers and amounts for the non-contingent hello and contingent break fees from its taxable income. At issue before the Court was whether these expenses were properly deducted from income for tax purposes.

It was the taxpayer's position that the expenses were incurred for the purpose of gaining or producing income, a threshold requirement for deductibility. It claimed the expenses were incurred pursuant to a hostile takeover bid and were expenditures needed to meet legal requirements and the expectations of the public capital markets. It was the government's position that the expenses were not deductible from business income because they were not incurred for the purpose of gaining or producing income but rather were incurred in response to a takeover bid and were aimed at maximizing shareholder value. The government also argued that, if such expenses were seen as having been made for the purpose of gaining or producing income, they were capital in nature. As such, they were not deductible because the Income Tax Act denies the deduction of any capital expense, except as expressly permitted.

Rejecting the government's argument as being fundamentally inconsistent with the economic and business realities of the mergers and acquisitions world, the Court held that it is a basic common-sense approach to view maximizing share price as interwoven with the business of any company: "It is simple logic that maximizing shareholder value must be inextricably tied to the bare bones of gaining or producing income on a daily basis in any corporate environment." Further, the Court determined that the expenses were not capital in nature because no capital asset was acquired, nothing of an enduring benefit came into existence and no capital asset was preserved. Lastly, since the expenses did not relate to a prior or subsequent period than the one from which they were deducted, the Court concluded that the taxpayer properly deducted the expenses against its business income.

This decision, for which the appeal period has now passed, is encouraging for taxpayers not only because it relates to break fees and other expenses related to the target of a takeover bid, but also because of the common-sense approach taken by the Court in considering the deductibility of the expenses.

By Shelby Anderson and Nicholas Dietrich

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